There is continuing interest in the study of the forces that impact on an organisation, particularly those

that can be harnessed to provide competitive advantage. The ideas and models which emerged during
the period from 1979 to the mid-1980s (Porter, 1998) were based on the idea that competitive advantage
came from the ability to earn a return on investment that was better than the average for the industry
sector (Thurlby, 1998).

As Porter's 5 Forces analysis deals with factors outside an industry that influence the nature of
competition within it, the forces inside the industry (microenvironment) that influence the way in which
firms compete, and so the industry’s likely profitability is conducted in Porter’s five forces model. A
business has to understand the dynamics of its industries and markets in order to compete effectively in
the marketplace. Porter (1980a) defined the forces which drive competition, contending that the
competitive environment is created by the interaction of five different forces acting on a business. In
addition to rivalry among existing firms and the threat of new entrants into the market, there are also the
forces of supplier power, the power of the buyers, and the threat of substitute products or services. Porter
suggested that the intensity of competition is determined by the relative strengths of these forces.

Main Aspects of Porter’s Five Forces Analysis

The original competitive forces model, as proposed by Porter, identified five forces which would impact on
an organization’s behaviour in a competitive market. These include the following:

• The rivalry between existing sellers in the market.

• The power exerted by the customers in the market.
• The impact of the suppliers on the sellers.
• The potential threat of new sellers entering the market.
• The threat of substitute products becoming available in the market.

Understanding the nature of each of these forces gives organizations the necessary insights to enable
them to formulate the appropriate strategies to be successful in their market (Thurlby, 1998).

Force 1: The Degree of Rivalry

The intensity of rivalry, which is the most obvious of the five forces in an industry, helps determine the
extent to which the value created by an industry will be dissipated through head-to-head competition. The
most valuable contribution of Porter's “five forces” framework in this issue may be its suggestion that
rivalry, while important, is only one of several forces that determine industry attractiveness.

• This force is located at the centre of the diagram;

• Is most likely to be high in those industries where there is a threat of substitute products; and existing
power of suppliers and buyers in the market.

Force 2: The Threat of Entry

Both potential and existing competitors influence average industry profitability. The threat of new entrants
is usually based on the market entry barriers. They can take diverse forms and are used to prevent an
influx of firms into an industry whenever profits, adjusted for the cost of capital, rise above zero. In
contrast, entry barriers exist whenever it is difficult or not economically feasible for an outsider to replicate
the incumbents’ position (Porter, 1980b; Sanderson, 1998) The most common forms of entry barriers,
except intrinsic physical or legal obstacles, are as follows:
• Economies of scale: for example, benefits associated with bulk purchasing;
• Cost of entry: for example, investment into technology;
• Distribution channels: for example, ease of access for competitors;
• Cost advantages not related to the size of the company: for example, contacts and expertise;
• Government legislations: for example, introduction of new laws might weaken company’s competitive
position;
• Differentiation: for example, certain brand that cannot be copied (The Champagne)

Force 3: The Threat of Substitutes

The threat that substitute products pose to an industry's profitability depends on the relative price-to-
performance ratios of the different types of products or services to which customers can turn to satisfy the
same basic need. The threat of substitution is also affected by switching costs – that is, the costs in areas
such as retraining, retooling and redesigning that are incurred when a customer switches to a different
type of product or service. It also involves:

• Product-for-product substitution (email for mail, fax); is based on the substitution of need;
• Generic substitution (Video suppliers compete with travel companies);
• Substitution that relates to something that people can do without (cigarettes, alcohol).

Force 4: Buyer Power

Buyer power is one of the two horizontal forces that influence the appropriation of the value created by an
industry (refer to the diagram). The most important determinants of buyer power are the size and the
concentration of customers. Other factors are the extent to which the buyers are informed and the
concentration or differentiation of the competitors. Kippenberger (1998) states that it is often useful to
distinguish potential buyer power from the buyer's willingness or incentive to use that power, willingness
that derives mainly from the “risk of failure” associated with a product's use.

• This force is relatively high where there a few, large players in the market, as it is the case with retailers
an grocery stores;
• Present where there is a large number of undifferentiated, small suppliers, such as small farming
businesses supplying large grocery companies;
• Low cost of switching between suppliers, such as from one fleet supplier of trucks to another.

Force 5: Supplier Power

Supplier power is a mirror image of the buyer power. As a result, the analysis of supplier power typically
focuses first on the relative size and concentration of suppliers relative to industry participants and second
on the degree of differentiation in the inputs supplied. The ability to charge customers different prices in
line with differences in the value created for each of those buyers usually indicates that the market is
characterized by high supplier power and at the same time by low buyer power (Porter, 1998). Bargaining
power of suppliers exists in the following situations:

• Where the switching costs are high (switching from one Internet provider to another);
• High power of brands (McDonalds, British Airways, Tesco);
• Possibility of forward integration of suppliers (Brewers buying bars);
• Fragmentation of customers (not in clusters) with a limited bargaining power (Gas/Petrol stations in
remote places).
The nature of competition in an industry is strongly affected by suggested five forces. The stronger the
power of buyers and suppliers, and the stronger the threats of entry and substitution, the more intense
competition is likely to be within the industry. However, these five factors are not the only ones that
determine how firms in an industry will compete – the structure of the industry itself may play an important
role. Indeed, the whole five-forces framework is based on an economic theory know as the “Structure-
Conduct-Performance” (SCP) model: the structure of an industry determines organizations’ competitive
behaviour (conduct), which in turn determines their profitability (performance). In concentrated industries,
according to this model, organizations would be expected to compete less fiercely, and make higher
profits, than in fragmented ones. However, as Haberberg and Rieple (2001) state, the histories and
cultures of the firms in the industry also play a very important role in shaping competitive behaviour, and
the predictions of the SCP model need to be modified accordingly.

How to write a Good Porter's 5 Forces analysis

The Porter’s Five Forces model is a simple tool that supports strategic understanding where
power lies in a business situation. It also helps to understand both the strength of a firm’s current
competitive position, and the strength of a position a company is looking to move into. Despite
the fact that the Five Force framework focuses on business concerns rather than public policy, it
also emphasizes extended competition for value rather than just competition among existing
rivals, and the simpleness of its application inspired numerous companies as well as business
schools to adopt its use (Wheelen and Hunger, 1998).

With a clear understanding of where power lies, it will enable a company to take fair advantage
of its strengths, improve weaknesses, and avoid taking wrong steps. Therefore, to apply this
planning tool effectively, it is important to understand the situation and to look at each of the
forces individually.

In conducting an analysis of Porter’s Five Forces, it is required to brainstorm all relevant factors
for the company’s market situation, and then check against the factors presented for each force in
the diagram above. The next step is to highlight the key factors on a diagram, and summarize the
size and the scale of the force on the diagram. It is suggested to use signs, as for instance, “+”
and “--" signs for the forces moderately in company’s favor, or for a force strongly against.

After identifying favourable and unfavourable forces for the company’s performance and
industry’s attractiveness, it is important to analyse the situation and examine the impacts of the
forces. One of the critical comments made of the Five Forces framework is its static nature,
whereas the competitive environment is changing turbulently. Are the five forces able to foresee
industry expansion? Is it the corporate strategist's goal to find a position in the industry where his
or her company can best defend itself against these forces or can influence them in its favour, or
is the goal to become part of the ongoing commerce with the intention to produce innovative
ideas that will expand the size of the industry? Is it true that the environment poses a threat to the
organisation, leading to the consideration of suppliers and buyers as threats that need to be
tackled, or does it offer the ground for a constitutive industry player co-operation?

By thinking through how each force affects a company, and by identifying the strength and
direction of each force, it provides with an opportunity to identify the strength of the position and
the ability to make a sustained profit in the industry (Mind Tools, 2006).

Limitations of Porter’s Five Force Model

Porter’s model is a strategic tool used to identify whether new products, services or businesses
have the potential to be profitable. However it can also be very illuminating when used to
understand the balance of power in other situations.

Porter argues that five forces determine the profitability of an industry. At the heart of industry
are rivals and their competitive strategies linked to, for example, pricing or advertising; but, he
contends, it is important to look beyond one’s immediate competitors as there are other
determines of profitability. Specifically, there might be competition from substitutes products or
services. These alternatives may be perceived as substitutes by buyers even though they are part
of a different industry. An example would be plastic bottles, cans and glass bottle for packaging
soft drinks. There may also be potential threat of new entrants, although some competitors will
see this as an opportunity to strengthen their position in the market by ensuring, as far as they
can, customer loyalty. Finally, it is important to appreciate that companies purchase from
suppliers and sell to buyers. If they are powerful they are in a position to bargain profits away
through reduced margins, by forcing either cost increases or price decreases. This relates to the
strategic option of vertical integration, when the company acquires, or mergers with, a supplier
or customer and thereby gains greater control over the chain of activities which leads from basic
materials through to final consumption (Luffman and et al., 1996; Wheelen and Hunger, 1998).

It is important to be aware that this model has further limitations in today's market environment;
as it assumes relatively static market structures. Based originally on the economic situation in the
eighties with its strong competition and relatively stable market structures, it is not able to take
into account new business models and the dynamism of the industries, such as
technological innovations and dynamic market entrants from start-ups that will completely
change business models within short times. For instance, the computer and software industry is
often considered as being highly competitive. The industry structure is constantly being
revolutionized by innovation that indicates Five Forces model being of limited value since it
represents no more than snapshots of a moving picture. Therefore, it is not advisable to develop a
strategy solely on the basis of Porter’s models (Kippenberger, 1998; Haberberg and Rieple,
2001), but to examine it in addition to other strategic frameworks of SWOT and PEST analysis.

Nevertheless, that does not mean that Porters theories became invalid. What needs to be done is
to adopt the model with the knowledge of their limitations and to use them as a part of a larger
framework of management tools, techniques and theories. This approach, however, is advisable
for the application of every business model (Recklies, 2001).

Porter's Six Forces model and its relationship to the standard Five Forces model

Porter’s Five Forces model actually has an extension referred to as Porter’s Six Forces model. It
is considerably less popular than the Five Forces model as its acceptance has been less positive
than the Five Forces model. The Six Forces model though is very similar to the Five Forces
model with the only difference being the addition of the sixth force in the framework. This sixth
force in the model is termed as the relative power of other stakeholders, and can refer to a
number of other groups or entities, depending on the factor which has the greatest influence
including:
• Complementors – One school of thought looks at the sixth force to be complementors,
which are businesses offering complementary products to the sector in focus and being analysed
(Grove 1996). The author states that these complementary businesses, as a sixth factor, affect the
industry as changes in these businesses (such as new techniques, approaches or technologies) can
impact on the dynamics between the industry and the complementors.
• The government – The sixth force in the framework can also be considered to be the
government, and is included in the framework if it has potential to impact on all the other five
forces (Gordon, 1997). Thus, the government can have direct impact in the industry as the sixth
force, but can also have indirect impact or influence by affecting the other five forces, whether
favourably or unfavourably.
• The public – Yet other viewpoints look at the public as the sixth force in the model,
particularly if the public has a strong influence in the dynamics of the sector resulting in changes
to the other forces or in the sector as a whole.
• Shareholders – This group can also be considered potentially as the sixth force. This is more
important in recent years where shareholder activity has increased significantly in the
boardroom, and management of firms has been scrutinised much more and even given ‘threats’ if
certain actions favoured by the shareholders were not pursued.
• Employees – Employees could also be considered as the sixth force if they wielded
extraordinarily strong influence on the firm in a particular sector. The status of employees seems
to follow similar rules in certain sectors, and thus could be considered a strong influence in these
sectors. For example, in the automobile sector in the US, a large part of the work force are
unionised, and thus could be considered the sixth force instead of the government or
complementors.

While a sixth force has been added to Porter’s original Five Forces model, the acceptance of this
framework has been somewhat limited. This could be for two reasons. First, is that there is no
definite and specific sixth force in all sectors, as it is different for each sector. Second, while a
sixth force could be defined for all sectors, the influence of this factor can also be captured in the
other five forces and thus the necessity of having it in the framework is less compelling.

Where to find information for Porter's 5 Forces analysis

In conducting the analysis it is crucial to examine the existing literature:

• Periodicals, business articles on the industry performance, etc;

• Analyst reports and trade organisations;
• Company annual reports and its publications on the main suppliers an distribution network;
• Anything that will give the exposure to the market situation, competitors present in the market,
new emerging companies in the industry.

It is important to make sure that the sources are reliable and relevant to the current condition of
the industry. It has to be viable, reliable and valid, in order to make conduct a good analysis of
the model. For this purpose, the gathered data and information has to be checked and be applied
to the current business conditions. Further limitations could be present in the nature of market
forces that reduce the applicability of the information sources to present situations; and the
amount of detailed information required. This can be prohibitive to its practical use. For
example, the level of competitor information required is very detailed and may not always be
available.

Conclusion
Any company must seek to understand the nature of its competitive environment if it is to be
successful in achieving its objectives and in establishing appropriate strategies. If a company
fully understands the nature of the Porter’s five forces, and particularly appreciates which one is
the most important, it will be in a stronger position to defend itself against any threats and to
influence the forces with its strategy. The situation is fluid, and the nature and relative power of
the forces will change. Consequently, the need to monitor and stay aware is continuous.

Some issues during the implementation of these Five Forces are crucially important for
organizations to build long-term business strategy and sustaining competitive advantages rather
than simply list the forces. Successful use of the Porter Model Analysis includes identifying the
sources of competition, the strength and likelihood of that competition existing, and strategic
recommendations for the action a company should take to in order to develop barriers to
competition.

If you found this article useful please have a look at the other articles we have written: PEST
analysis, SWOT analysis, Ansoff analysis, BCG Growth-Share Matrix, Porter's Generic
Strategies,Scenario Planning, Value chain analysis.

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 Home > Tutorials
1. Stock Picking
2. Forex
The Industry Handbook: The Oil Services Industry
3. Options Trading
4. Credit Crisis Printer friendly version (PDF format)
Topics There is no doubt that the oil/energy industry is extremely large. According to the Department of Energy (DOE), fossil fuels (i
natural gas) makes up more than 85% of the energy consumed in the U.S. as of 2008. Oil supplies 40% of U.S. energy need
Department of Energy's Energy Sources information page for more insight.)
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Before petroleum can be used, it is sent to a refinery where it is physically, thermally and chemically separated into fractions
Stock Ideas into finished products. About 90% of these products are fuels such as gasoline, aviation fuels, distillate and residual oil, lique
(LPG), coke (not the refreshment) and kerosene. Refineries also produce non-fuel products, including petrochemicals, aspha
Free Tools solvents and wax. Petrochemicals (ethylene, propylene, benzene and others) are shipped to chemical plants, where they are
chemicals and plastics. (For more insight, read Oil And Gas Industry Primer.)
Calculators
There are two major sectors within the oil industry, upstream and downstream. For the purposes of this tutorial we will focus
the process of extracting the oil and refining it. Downstream is the commercial side of the business, such as gas stations or t
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heat.

Oil Drilling and Services

Oil drilling and services is broken into two major areas: drilling and oilfield services.
• Drilling - Drilling companies physically drill and pump oil out of the ground. The drilling industry has always been c
skilled. The people with the skills and expertise to operate drilling equipment are in high demand, which means tha
to have these people on staff all the time can cost a lot. For this reason, most drilling companies are simply contra
oil and gas producers for a specified period of time. (For related reading, see Unearth Profits In Oil Exploration An

In the drilling industry, there are several different types of rigs, each with a specialized purpose. Some of these inc
• Land Rigs - Drilling depths ranges from 5,000 to 30,000 feet.
• Submersible Rigs - Used for ocean, lake and swamp drilling. The bottom part of these rigs are submer
and the platform is on top of the water.
• Jack-ups - this type of rig has three legs and a triangular platform which is jacked-up above the highest
• Drill Ships - These look like tankers/ships, but they travel the oceans in search of oil in extremely deep

(For more information on the drilling industry, check out on the Rigzone website.)
• Oilfield Services - Oilfield service companies assist the drilling companies in setting up oil and gas wells. In gene
companies manufacture, repair and maintain equipment used in oil extraction and transport. More specifically, thes
include:
• Seismic Testing - This involves mapping the geological structure beneath the surface.
• Transport Services - Both land and water rigs need to be moved around at some point in time.
• Directional Services - Believe it or not, all oil wells are not drilled straight down, some oil services comp
 drilling angled or horizontal holes.

The energy industry is not any different than most commodity-based industries as it faces long periods of boom and bust. Dr
service firms are highly dependent on the price and demand for petroleum. These firms are some of the first to feel the effec
decreased spending. If oil prices rise, it takes time for petroleum companies to size up land, setup rigs, take out the oil, trans
before the oil company sees any profit. On the other hand, oil services and drilling companies are the first on the scene when
start exploring.

Oil Refining
The refining business is not quite as fragmented as the drilling and services industry. This sector is dominated by a small han
In fact, much of the energy industry is ruled by large, integrated oil companies. Integrated refers to the fact that many of thes
after all factors of production, refining and marketing.

For the most part, refining is a slow and stable business. The large amounts of capital investment means that very few comp
enter this business. This handbook will try to focus more on oil equipment and services such as drilling and support services

Key Ratios/Terms

BTUs: Short for "British Thermal Units." This is the amount of heat required to increase the temperature of one pound of wa
Fahrenheit. Different fuels have different heating values; by quoting the price per BTU it is easier to compare different types

Dayrates: Oil and gas drillers usually charge oil producers on a daily work rate. These rates vary depending on the location,
market conditions. There are plenty of research firms that publish this information. Higher dayrates are great for drilling comp
and distribution companies this means lower margins unless energy prices are rising at the same rate.

Meterage: Another type of contract that differs from dayrates is one based on how deep the rig drills. These are called meter
contracts. These are less desirable because the depth of the oil deposits are unpredictable; it's really a gamble on the driller'

Downstream: Refers to oil and gas operations after the production phase and through to the point of sale, whether at the ga
heating oil truck

Upstream: The grass roots of the oil business, upstream refers to the exploration and production of oil and gas. Many analy
expenditures from previous quarters to estimate future industry trends. For example, a decline in upstream expenditures usu
other areas such as transportation and marketing.

OPEC: The Organization of Petroleum Exporting Countries is an intergovernmental organization dedicated to the stability an
petroleum market. OPEC membership is open to any country that is a substantial exporter of oil and that shares the ideals o
OPEC has 11 member countries. Output quotas placed by OPEC can send huge shocks throughout the energy markets.

Below is a chart of the world's top exporters of petroleum. OPEC members are denoted by "*". Indonesia and Qatar are also
they don't make the top twelve.

Top World Oil Net Exporters, 2006

Country Net Exports (million barrels per day)
1) Saudi Arabia* 8.65
2) Russia 6.57
3) Norway 2.54
4) Iran* 2.52
5) United Arab Emirates* 2.52
6) Venezuela* 2.20
7) Kuwait* 2.15
8) Nigeria* 2.15
9) Algeria* 1.85
10) Mexico 1.68
11) Libya* 1.52
12) Iraq* 1.43

Source: Energy Information Administration

Analyst Insight
Analysts and investors often disagree on specific investment decisions, but one thing that they do agree on is their approach
companies. A top down investment approach is almost always the best strategy. We will go through the top down steps belo
read A Top-Down Approach To Investing.)

Economics/Politics
The oil industry is easily influenced by economic and political conditions. If a country is in a recession, fewer products are be
as many people drive to work, take vacations, etc. All of these variables factor into less energy use. The best time to invest in
when the economy is firing on all cylinders and oil companies are making so much money that using excessive amounts of e
little effect on their bottom line.

Some analysts believe that rather than analyzing energy companies, you should just predict the trend in energy prices. While
needed for a prudent investment than simply looking at price trends in oil, it's true that there is a strong correlation between t
energy companies and the commodity price for energy.

Supply and Demand

Oil and gas prices fluctuate on a minute by minute basis, taking a look at the historical price range is the first place you shou
determine the price of oil, but it really all comes down to supply and demand. Demand typically does not fluctuate too much (
recession), but supply shocks can occur for a number of reasons. When OPEC meets to determine oil supply for the coming
oil can fluctuate wildly. Day-to-day fluctuations should not influence your investment decision in a particular energy company
should be followed more closely. You can find the latest energy supply/demand statistics at the Energy Information Administ

Rig Utilization Rates

Another factor that determines supply is the rig utilization rates; its close relationship to oil prices is not a coincidence. Highe
mean more revenue and profits. For drilling companies, it is important to take a close look at the company's rig fleet, because
ability to drill in remote locations or to bore deep holes. Some other factors to consider are the depth of water that the offshor
depth and horsepower. Higher quality rigs will have higher utilization rates, especially during weak periods. This will lead to h
Sometimes this is a double-edged sword; while higher utilization is better, a company that is at its capacity will have difficulty
further.

Contracts
The contracts through which an oil services company is paid also play a large role in supply. Pay close attention to the dayra
dayrates can dramatically decrease revenues. The opposite is true should dayrates rise. This is because many of the drillers

Financial Statements
After these wide scale factors have been considered, it's time to get down to the nitty gritty - the financials. And when it come
the same old rules apply to oil services companies. Ideally, revenues and profits will be growing consistently, just as they do
company. It's worth digging deeper to see if there are any one-time events that have dramatically increased revenues. Also,
ratios should be comparable to others within the industry.

On the balance sheet, investors should keep an eye on debt levels. High debt puts a strain on credit ratings, weakening their
new equipment or finance other capital expenditures. Poor credit ratings also make it difficult to acquire new business. If cus
choice of going with a company that is strong versus one that is having debt problems, which do you think they will choose?
financial leverage, take a look at the debt/equity ratio. The working capital also tells us whether the company has enough liqu
short term liabilities. Rating agencies like Moody's and S&P say 50% is a prudent debt/equity ratio. Companies in more stabl
slightly higher debt/equity ratios.

If profits are of the utmost importance, then the statement of cash flow is a close second. Oil companies are notorious for re
items in the income statement. For this reason, you should try to decipher the cash EPS. By stripping away all the non-cash
truer number because cash flow cannot be manipulated as easily as net income can. (For further reading, see Advanced Fin
Analysis.)

Porter's 5 Forces Analysis

1. Threat of New Entrants. There are thousands of oil and oil services companies throughout the world, but the barr
industry are enough to scare away all but the serious companies. Barriers can vary depending on the area of the m
company is situated. For example, some types of pumping trucks needed at well sites cost more than $1 million ea
the oil business require highly specialized workers to operate the equipment and to make key drilling decisions. Co
such as these have higher barriers to entry than ones that are simply offering drilling services or support services.
another barrier - a company had better have deep pockets to take on the existing oil companies.
2. Power of Suppliers. While there are plenty of oil companies in the world, much of the oil and gas business is dom
handful of powerful companies. The large amounts of capital investment tend to weed out a lot of the suppliers of r
etc. There isn't a lot of cut-throat competition between them, but they do have significant power over smaller drillin
companies.
3. Power of Buyers. The balance of power is shifting toward buyers. Oil is a commodity and one company's oil or oil
not that much different from another's. This leads buyers to seek lower prices and better contract terms.
4. Availability of Substitutes. Substitutes for the oil industry in general include alternative fuels such as coal, gas, s
 power, hydroelectricity and even nuclear energy. Remember, oil is used for more than just running our vehicles, it
plastics and other materials. When analyzing an energy company it is extremely important to take a close look at t
which the company is operating. Also, companies offering more obscure or specialized services such as seismic d
drilling tools are much more likely to withstand the threat of substitutes. (For more on oil substitutes, see The Biofu
Up.)
5. Competitive Rivalry. Slow industry growth rates and high exit barriers are a particularly troublesome situation fac
quite recently, oil refineries were a particularly good example. For a period of almost 20 years, no new refineries w
Refinery capacity exceeded the product demands as a result of conservation efforts following the oil shocks of the
time, exit barriers in the refinery business are quite high. Besides the scrap value of the equipment, a refinery that
no value-adding capability. Almost every refinery can do one thing - produce the refined products they have been d

Key Links
• Department of Energy - Get the latest regulation news and statistics. You name it, this site has it.
• ODS-Petrodata - Both free and fee-based data on rig counts and other key figures in the oil services industry.
• Rigzone.com - News and statistics on the oil and gas industry.

Next: The Industry Handbook: Precious Metals

Table of Contents
1) The Industry Handbook: Overview
2) Industry Handbook: Porter's 5 Forces Analysis
3) The Industry Handbook: The Airline Industry
4) The Industry Handbook: The Oil Services Industry
5) The Industry Handbook: Precious Metals
6) The Industry Handbook: Automobiles
7) The Industry Handbook: The Retailing Industry
8) The Industry Handbook: The Banking Industry
9) The Industry Handbook: Biotechnology
10) The Industry Handbook: The Semiconductor Industry
11) The Industry Handbook: The Insurance Industry
12) The Industry Handbook: The Telecommunications
Industry
13) The Industry Handbook: The Utilties Industry
14) The Industry Handbook: The Internet Industry

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If you are not familiar with the five competitive forces model, here is a brief background on who developed it, and why it is useful.

The model originated from Michael E. Porter's 1980 book "Competitive Strategy: Techniques for Analyzing Industries and
Competitors." Since then, it has become a frequently used tool for analyzing a company's industry structure and its corporate
 strategy.

In his book, Porter identified five competitive forces that shape every single industry and market. These forces help us to analyze
everything from the intensity of competition to the profitability and attractiveness of an industry. Figure 1 shows the relationship
between the different competitive forces.

Figure 1: Porter's five competitive forces

1. Threat of New Entrants - The easier it is for new companies to enter the industry, the more cutthroat competition there
will be. Factors that can limit the threat of new entrants are known as barriers to entry. Some examples include:

• Existing loyalty to major brands

• Incentives for using a particular buyer (such as frequent shopper programs)
• High fixed costs
• Scarcity of resources
• High costs of switching companies
• Government restrictions or legislation

Power of Suppliers - This is how much pressure suppliers can place on a business. If one supplier has a large enough impact to affect a
company's margins and volumes, then it holds substantial power. Here are a few reasons that suppliers might have power:

• There are very few suppliers of a particular product

• There are no substitutes
• Switching to another (competitive) product is very costly
 • The product is extremely important to buyers - can't do without it
• The supplying industry has a higher profitability than the buying industry

Power of Buyers - This is how much pressure customers can place on a business. If one customer has a large enough impact to affect a
company's margins and volumes, then the customer hold substantial power. Here are a few reasons that customers might have
power:

• Small number of buyers

• Purchases large volumes
• Switching to another (competitive) product is simple
• The product is not extremely important to buyers; they can do without the
product for a period of time
• Customers are price sensitive

Availability of Substitutes - What is the likelihood that someone will switch to a competitive product or service? If the cost of switching is low,
then this poses a serious threat. Here are a few factors that can affect the threat of substitutes:

• The main issue is the similarity of substitutes. For example, if the price of coffee
rises substantially, a coffee drinker may switch over to a beverage like tea.
• If substitutes are similar, it can be viewed in the same light as a new entrant.

Competitive Rivalry - This describes the intensity of competition between existing firms in an industry. Highly competitive industries generally
earn low returns because the cost of competition is high. A highly competitive market might result from:

• Many players of about the same size; there is no dominant firm

• Little differentiation between competitors products and services
• A mature industry with very little growth; companies can only grow by stealing
customers away from competitors